Certain Financial institution custodians and other administrators of limited-purpose tax-advantaged accounts and arrangements such as 529 Plans (529s), Coverdell Education Savings Accounts (ESAs), Health Savings Accounts (HSAs), Medical Savings Accounts (MSAs), Health Reimbursement Arrangements (HRAs), and Flexible Spending Arrangements (FSAs) provide one of two primary methods for making withdrawals from the accounts, and certain methods of otherwise managing the accounts.
The first method for making withdrawals (generally offered with 529s and ESAs) does not permit the account holder or beneficiary to make withdrawals self-sufficiently; they must contact the custodian and direct disbursement of funds in a lump-sum to another account they control rather than directly to the supplier of the goods or services which qualify for favorable tax treatment. This process could be termed prospective reimbursement.
The second method for making withdrawals (generally offered with HSAs and FSAs) involves a standard combination of withdrawal methods commonly used with traditional demand deposit accounts including: checks, debit cards, on-line bill pay applications, and on-line transfers. Under this method, account holders can choose to pay the supplier of the goods or services which qualify for favorable tax treatment directly, to disburse money to another account they control and from which they have effected payment to the qualifying supplier, or to otherwise reimburse themselves for a qualifying expense. IRS Publication 969 describes the acceptability of reimbursing oneself from an HSA for qualifying expenses paid outside the HSA. This process could be termed retrospective reimbursement.
Custodians of limited-purpose tax-advantaged accounts often provide other methods for managing the account, including the ability for the account holder to view statements on-line, and to enter notes including recording information regarding the qualification or non-qualification of a withdrawal. In the case of HSAs, some custodians allow account holders the ability to upload images of expenditure receipts as part of their notes.
The total set of account management methods currently provided by custodians of limited-purpose tax-advantaged accounts has at least five shortcomings. First, there are no methods for account holders to identify or keep records surrounding any qualifying tax-advantaged expenditures which may be made: (i) from another account and are permitted to be reimbursed from the limited-purpose account (in the case of retrospective reimbursement), or (ii) against a balance already withdrawn from the limited-purpose account (in the case of prospective reimbursement). This shortcoming burdens the use of limited-purpose accounts and places a substantial record-keeping requirement on the account holder with no information technology tools to discharge it.
A second shortcoming of existing account management methods is that custodians of limited-purpose tax-advantaged accounts do not offer any methods for account holders to calculate the amount of or execute contributions to limited-purpose accounts (either directly or from payroll deductions at the account holder's employer if permitted) as a function of the account holder's saving goals, Federally-established contribution limits, and/or projected or prior expenditures from other accounts which qualify for prospective or retrospective reimbursement from the limited-purpose account. This limitation places a research, calculation and execution burden on the account holder to maximize the financial efficiency of their contributions to the account.
A third shortcoming of existing account management methods is that custodians of limited-purpose tax-advantaged accounts do not offer any methods for account holders to determine which withdrawals may not have been qualifying for purposes of restoring money to the limited-purpose tax-advantaged account or offsetting the total otherwise reimbursable from the limited-purpose tax-advantaged account. This limitation also creates a record-keeping and possibly a tax burden to the account holder.
A fourth shortcoming of existing account management methods is that custodians of limited-purpose tax-advantaged accounts do not offer any methods for automating reimbursements to the account holder based on information about: (i) qualifying expenditures made from another account or (ii) contributions to the limited-purpose tax-advantaged account. Thus the account holder must request a reimbursement each time such an event happens and cannot issue standing reimbursement orders to the custodian. This limitation places a time, scheduling, and cash flow burden on the account holder.
A fifth shortcoming of existing account management methods is that, in the case of limited-purpose accounts for which the custodian offers only prospective reimbursement, the custodian provides no methods for making direct payment of qualifying expenses; rather, money must be withdrawn in a lump sum and qualifying expenses paid individually out of another account. There are no custodian-provided methods for effecting these payments or keeping records for tax and audit purposes. This limitation places an additional record-keeping burden on the account holder.